Related disclosure document posts:
- Franchise Rule Disclosure Compliance Obligations
- Ways of Furnishing Disclosure Documents
- Sample Franchise Agreement / Disclosure Document
- When Must Disclosure Documents Be Furnished?
Does failure to provide mandated disclosure documents prior to the entering into a franchise agreement vitiate the subsequent agreement?
Federal Laws Regarding the Sale of Franchises
Both federal and state law regulates the sale of franchises. On the federal level, the Federal Trade Commission’s (the “Commission”) Franchise Rule (“FTC Rule”) was promulgated in 1979 and was recently amended in 2007. (See footnote 1.) The FTC Rule requires franchisors to provide a minimum level of pre-sale disclosure to prospective franchisees. (See footnote 2.) The rule requires franchisors to provide prospective franchisees with sufficient information about the franchisor and the franchised business being offered for sale. (See footnote 3.) Specifically, the FTC Rule makes it an unfair or deceptive act or practice for any franchisor to fail to furnish a prospective franchisee with a copy of the franchisor’s current disclosure documents at least fourteen (14) calendar days before the prospective franchisor signs a binding agreement, or makes any payment to, the franchisor. (See footnote 4.) Here, the federal regulation is narrower than the law in Minnesota where disclosure must be completed before even an offer can be made. (See footnote 5.)
The Commission has the power to impose the following penalties for violations of the FTC Rule:
- civil penalties of up to $10,000 per day for each violation of the FTC Rule or a Commission cease and desist order;
- Commission may compel rescission or reformation of contracts; or
- may issue a cease and desist order requiring a party to refrain from engaging in any unfair method of competition or deceptive act or practice in or affecting commerce. (See footnote 6.)
Private citizens cannot sue franchisors for violations of the FTC Rule. (See footnote 7.) Only the FTC can take action to enforce the rule. (See footnote 8.) Nevertheless, private citizens may have available causes of action and remedies under Minnesota state law.
Minnesota Laws Surrounding the Sale of Franchises
The Minnesota Department of Commerce regulates the registration of franchises in Minnesota. Before a franchise can be offered or sold, it must be registered in accordance with the Minnesota Franchise Act (See footnote 9), and the rules of the Department of Commerce. (See footnote 10.)
As part of the registration process, a franchisor is required to prepare a public offering statement in accordance with Minnesota Statutes Chapter 80C. According to section 80C.02: “No person may offer or sell any franchise in this state unless there is an effective registration (including a public offering statement) on file in accordance with the provisions of sections 80C.01 to 80C.22.” For the purposes of sections 80C.01 to 80C.22, an offer to sell or to purchase is made in this state when the offer originates from this state or is directed by the offeror to this state and received by the offeree in this state. (See footnote 11.)
Any person who violates the Minnesota Franchise Act may be liable to the franchisee or franchisor that is harmed by the violation for actual damages and lost profits, as well as cots, disbursements, and attorneys’ fees. (See footnote 12.) Similarly, a franchisee is also entitled to rescind the franchise agreement if he/she chooses. (See footnote 13). Section 80C.17(1) reads:
“A person who violates any provision of sections 80C.01 to 80C.13 and 80C.15 to 80C.22 or any rule or order thereunder shall be liable to the franchisee or subfranchisor who may sue for damages caused thereby, for rescission, or other relief as the court may deem appropriate.”
In Chase Manhattan Bank v. Clusiau Sales & Rental, Inc., the court interpreted section 80C.17(1) to declare the legislature’s intent to afford a franchisee who suffers harm by reason of the franchisor’s violation of the franchise statute the right to have his agreements with the franchisor treated as entirely void and to be restored to the position he occupied prior to his involvement with the franchisor. (See footnote 14). Specifically, the court stated, “[t]he effect of the remedy of rescission is generally to extinguish a rescinded contract so effectively that in contemplation of the law it never had existence.” (See footnote 15.)
In addition, any person who directly or indirectly controls the liable person or who materially aids in the act in violation of the statute is jointly and severally liable. (See footnote 16.) This gives the franchisee the ability to sue not only the franchisor but all of the officers and directors of the franchisor. Liability can be avoided only if the person shows he or she had no actual or reasonable means of attaining knowledge of the violation. (See footnote 17.)
Choice of Law Provisions
A franchise agreement that contains a choice-of-law provision may leave the franchisor or franchisee without remedy should the other party violate the agreement. A choice-of-law provision is a clause in a contract that states that the contract will be construed in accordance with the laws of a particular jurisdiction. These provisions are often included in contracts where the parties are not residents of the same state. This is particularly significant where the state law governing a franchise agreement does not require the franchisor to make certain disclosures—stripping a franchisee of his or her right to sue.
The federal FTC Rule does not create a private cause of action. (See footnote 18.) Thus, injured franchisors and franchisees are left with state law as their sole remedy in cases where a franchisor fails to disclose certain documents. Currently, there are only fifteen (15) states that require a franchisor to disclose certain documents prior to sale. These states include California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin. (See footnote 19.) For this reason, it is exceedingly important to speak with an experienced attorney prior to entering into a franchise agreement.
 Minn. Stat. § 80C.17, subdiv. 1 (2012). See Nauman v. J’s Reestaurants Int’l, Inc., 316 N.W.2d 523 (Minn. 1982); Chase Manhattan Bank v. Clusiau Sales & Rental, Inc., 308 N.W.2d 490 (Minn. 1981); Martin investors, Inc. v. Vander Bie, 269 N.W.2d 868 (Minn. 1987).